Internationalization of the Renminbi

The Chinese government’s active promotion of the internationalization of the renminbi (RMB) raises questions related to motivation, financial reform, credibility and international financial stability. To learn more about the situation in these and other areas, CIGI Senior Fellow Hongying Wang speaks with CIGI-INET grantee Barry Eichengreen, professor of economics and political science at the University of California, Berkeley, and research associate at the National Bureau of Economic Research.

CIGI: The Chinese government has actively promoted the internationalization of the RMB. What are the motivations behind this policy?

Barry Eichengreen: The internationalization of the Chinese currency could involve risks and burdens. The motivations are several, and it may be dangerous and a bit misleading to attribute them to “the Chinese government.” Different factions or agencies have different views. Some see RMB internationalization as a way of enhancing the competitiveness of Chinese banks and firms. Others see it as a way of reducing the country’s dependence on the dollar. Still others see it as a mechanism for increasing the pressure for capital account liberalization and, therefore, for the package of reforms that should accompany it (a more flexible exchange rate, full commercialization of the banks and strengthened supervision and regulation). There is by no means a single motivation.

CIGI: Thus far, the internationalization of the RMB has mainly taken place in cross-border trade settlement, RMB-denominated bond issuance, RMB-denominated foreign direct investment and currency swaps. What do you see as the next stage of this process?

Eichengreen: The next stages are likely to involve broadening and deepening recent initiatives (widening the range of financial transactions that foreigners can engage in in China and that residents can undertake offshore), agreeing to the establishment of clearing banks in a number of additional foreign financial centres (London, for example) and establishing (or at least preparing to establish) a free trade and financial zone in Shanghai.

CIGI: Many scholars inside and outside China have argued that capital account liberalization could be risky for China without domestic financial reform first. But domestic financial reform faces serious political obstacles. Do you think Chinese policy makers will actually be willing and able to liberalize the financial sector in China in the foreseeable future?

Eichengreen: Chinese officials are likely to approach this problem like they approach other elements of the reform agenda: gradually, incrementally and progressively (“feeling the stones beneath the water,” if we can invoke that phrase one last time). I think capital account liberalization is a process, not a state. China will continue to move gradually in that direction, relaxing and removing controls one at a time. The question is whether Chinese policy makers might at some point lose control of the process, allowing the capital account to begin opening spontaneously — and faster than is desirable — as a result of arbitrage. That’s the risk.

CIGI: Credibility is very important for a country if its currency is to be internationalized. What is China doing to establish that credibility?

Eichengreen: It’s trying to reform financial supervision and regulation and make oversight of financial markets more transparent. It’s also trying to bring shadow banks (trust vehicles and the like) inside the regulatory perimeter. It’s signalling that no big finance company or bond issuer is too big to fail. The question is whether this will be enough. China has to strengthen contract enforcement and rule of law as well to gain the full confidence of international investors. One wonders whether or not this will ultimately require far-reaching changes in political as well as economic and financial arrangements.

CIGI: Some people have expressed concern that China could use “the power of currencies” to gain political influence. Should this be a concern for other countries?

Eichengreen: I tend to think that “currency power” is underrated. China can try to use the provision of emergency liquidity selectively, to reward its friends and punish its neighbours. But if that emergency liquidity is not provided freely, and to a wide range of countries, at times of crisis, international use of the RMB will be less attractive, and China’s efforts to promote it will be frustrated.

CIGI: People seem to expect the RMB to become a major international currency because of the size of the Chinese economy and its trading power. Do you see the RMB as more capable than the euro and the yen of challenging the dominance of the US dollar?

Eichengreen: China’s size works in favour of a major international role for its currency, and China will be the largest economy in the world in the not too distant future. But a national unit is attractive as an international currency only if that unit is stable and markets in it are liquid. Building liquid markets is a major challenge, and meeting it requires much more than sheer economic size. So China has a long way to go before the RMB can rival the dollar or even the euro on the global stage.

CIGI: Will the internationalization of the RMB be beneficial for the stability and sustainability of the international financial system?

Eichengreen: Insofar as an adequate supply of global liquidity is the objective, RMB internationalization is an unmitigated good thing. The United States can’t continue to provide the safe and liquid assets that an expanding global economy needs all on its own. US fiscal capacity is limited, and it will grow more limited as other countries continue to grow even faster than the United States. Other large economies will have to step up as suppliers of liquidity, and China is an obvious candidate.

Competition from China will also be a constructive source of discipline on US policy makers. If countries can turn to China instead of the United States for the liquidity they need, US policy makers will feel more pressure to behave themselves! And that, in turn, will be a stabilizing influence on the world economy and its monetary and financial system.

Barry Eichengreen is a prominent and highly distinguished economist and economic historian whose widely read books, articles and policy papers have made a prolific contribution to the study of international finance and global economic governance. He is currently professor of economics and political science at the University of California, Berkeley, and Research Associate of the National Bureau of Economic Research (Cambridge, Massachusetts).

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